Intermediate accounting 15e kieso warfield chapter 09

INTERMEDIATE

Intermediat
ACCOUNTING
Intermediat
e
e
Accounting
Accounting
F I F T E E N T H

9-1

E D I T I O N

Prepared by
Coby Harmon
Prepared by
Prepared by
University of California,
Barbara
CobySanta
Harmon
Harmon
Westmont
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University
of California,
Barbara
University of California, Santa Barbara
Westmont College

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weygandt
warfield
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PREVIEW OF CHAPTER

9

Intermediate Accounting
15th Edition
Kieso Weygandt Warfield
9-2


9

Inventories: Additional
Valuation Issues

LEARNING
LEARNINGOBJECTIVES
OBJECTIVES
After studying this chapter, you should be able to:

9-3

1.

Describe and apply the lower-of-cost-ormarket rule.

5.

Determine ending inventory by applying
the gross profit method.

2.

Explain when companies value
inventories at net realizable value.

6.

Determine ending inventory by applying
the retail inventory method.

3.

Explain when companies use the relative
sales value method to value inventories.

7.

Explain how to report and analyze
inventory.

4.

Discuss accounting issues related to
purchase commitments.


Lower-of-Cost-or-Market
A company abandons the historical cost principle when the
future utility (revenue-producing ability) of the asset drops
below its original cost.

9-4



Market = Replacement Cost.



Value goods at cost or cost to replace, whichever is
lower.



Loss should be recorded when
loss occurs, not in the period of sale.

LO 1 Describe and apply the lower-of-cost-or-market rule.


Lower-of-Cost-or-Market
Illustration 9-1

Lower-of-Cost-orMarket Disclosures

9-5

LO 1


Lower-of-Cost-or-Market
Ceiling and Floor
Why use Replacement Cost (RC) for Market?

9-6



Decline in the RC usually = decline in selling price.



RC allows a consistent rate of gross profit.



If reduction in RC fails to indicate reduction in utility, then
two additional valuation limitations are used:
►

Ceiling - net realizable value and

►

Floor - net realizable value less a normal profit margin.

LO 1 Describe and apply the lower-of-cost-or-market rule.


Lower-of-Cost-or-Market
Net realizable value (NRV) is the is the estimated selling
price in the ordinary course of business, less reasonably
predictable costs of completion and disposal (often referred
to as net selling price).
Illustration 9-2

9-7

LO 1 Describe and apply the lower-of-cost-or-market rule.


Lower-of-Cost-or-Market
Illustration 9-3

What is the rationale for the
Ceiling and Floor limitations?

Ceiling = NRV
Not
>

Cost
Cost

Market
Market

Replacement
Cost
Not
<

GAAP
GAAP
LCM
LCM
9-8

Floor =
NRV less Normal
Profit Margin
LO 1 Describe and apply the lower-of-cost-or-market rule.


Lower-of-Cost-or-Market
What is the rationale for the Ceiling and Floor limitations?

9-9



Ceiling – prevents overstatement of the value of obsolete,
damaged, or shopworn inventories.



Floor – deters understatement of inventory and
overstatement of the loss in the current period.

LO 1 Describe and apply the lower-of-cost-or-market rule.


Lower-of-Cost-or-Market
How Lower-of-Cost-or-Market Works
Illustration 9-5

9-10

Advance slide in
presentation mode to
reveal answers.

LO 1 Describe and apply the lower-of-cost-or-market rule.


Lower-of-Cost-or-Market
Methods of Applying Lower-of-Cost-or-Market
Illustration 9-6

9-11

Advance slide in
presentation mode to

reveal answers.

LO 1 Describe and apply the lower-of-cost-or-market rule.


Lower-of-Cost-or-Market
Recording “Market” Instead of Cost
Ending inventory (cost)
Ending inventory (market)
Adjustment to LCM

70,000
$ 12,000

Loss
Loss
Method
Method

Loss Due to Decline in Inventory

COGS
COGS
Method
Method

Cost of Goods Sold

9-12

$ 82,000

12,000

Allowance to Reduce Inventory to Market

Inventory

12,000

12,000
12,000

LO 1 Describe and apply the lower-of-cost-or-market rule.


Lower-of-Cost-or-Market
Balance Sheet

9-13

LO 1 Describe and apply the lower-of-cost-or-market rule.


Lower-of-Cost-or-Market
Income Statement

9-14

LO 1

Lower-of-Cost-or-Market
Illustration: Remmers Company manufactures desks. The company
attempts to obtain a 20% gross margin on selling price. At December 31,
2014, the following finished desks appear in the company’s inventory.

The 2014 catalog was in effect through November 2014, and the 2015
catalog is effective as of December 1, 2015.
Instructions: At what amount should each of the four desks appear in the
company’s December 31, 2015, inventory, assuming that the company has
adopted a lower-of-FIFO-cost-or-market approach for valuation of
inventories on an individual-item basis?
9-15

LO 1


Lower-of-Cost-or-Market
Ceiling = 450
(500 – 50)
Not
>

Replacement
Cost = 460

Cost
Cost == 470
470

Market
Market == 450
450

Not
<

Floor = 350
(450-(500 x 20%))

LCM
LCM == 450
450
9-16

LO 1


Lower-of-Cost-or-Market
Ceiling = 480
(540 – 60)
60)
Not
>

Replacement
Cost = 430

Cost

Cost == 450
450

Market
Market == 430
430

Not
<

Floor = 372
(480-(540 x 20%))

LCM
LCM == 430
430
9-17

LO 1


Lower-of-Cost-or-Market
Ceiling = 820
(900 – 80)
Not
>

Replacement
Cost = 610

Cost
Cost == 830
830

Market
Market == 640
640

Not
<

Floor = 640
(820-(900 x 20%))

LCM
LCM == 640
640
9-18

LO 1


Lower-of-Cost-or-Market
Ceiling = 1,070
(1,200
(1,200 – 130)
Not
>

Replacement

Cost = 1,000

Cost
Cost == 960
960

Market
Market == 1,000
1,000

Not
<

Floor = 830
(1,070-(1,200
(1,070-(1,200 xx 20%))
20%))

LCM
LCM == 960
960
9-19

LO 1


Lower-of-Cost-or-Market
Use of an Allowance—Multiple Periods
In general, accountants leave the allowance account on the
books. They merely adjust the balance at the next year-end to

agree with the discrepancy between cost and the lower-of-costor-market at that balance sheet date.
Illustration 9-10

9-20

LO 1 Describe and apply the lower-of-cost-or-market rule.


Lower-of-Cost-or-Market
Evaluation of Lower-of-Cost-or-Market Rule
Some Deficiencies:

9-21



Expense recorded when loss in utility occurs. Profit on sale
recognized at the point of sale.



Inventory valued at cost in one year and at market in the next
year.



Net income in year of loss is lower. Net income in subsequent
period may be higher than normal if expected reductions in
sales price do not materialize.



LCM uses a “normal profit” in determining inventory values,
which is a subjective measure.
LO 1 Describe and apply the lower-of-cost-or-market rule.


9

Inventories: Additional
Valuation Issues

LEARNING
LEARNINGOBJECTIVES
OBJECTIVES
After studying this chapter, you should be able to:
1.

Describe and apply the lower-of-cost-ormarket rule.

5.

Determine ending inventory by applying
the gross profit method.

2.

Explain when companies value
inventories at net realizable value.

6.

Determine ending inventory by applying
the retail inventory method.

3.

Explain when companies use the relative
sales value method to value inventories.

7.

Explain how to report and analyze
inventory.

4.

Discuss accounting issues related to
purchase commitments.

9-22


Valuation Bases
Valuation at Net Realizable Value
Permitted by GAAP under the following conditions:
(1) a controlled market with a quoted price applicable to all
quantities, and
(2) no significant costs of disposal
or

(3) too difficult to obtain cost figures.

9-23

LO 2 Explain when companies value inventories at net realizable value.


9

Inventories: Additional
Valuation Issues

LEARNING
LEARNINGOBJECTIVES
OBJECTIVES
After studying this chapter, you should be able to:
1.

Describe and apply the lower-of-cost-ormarket rule.

5.

Determine ending inventory by applying
the gross profit method.

2.

Explain when companies value
inventories at net realizable value.

6.

Determine ending inventory by applying
the retail inventory method.

3.

Explain when companies use the relative
sales value method to value inventories.

7.

Explain how to report and analyze
inventory.

4.

Discuss accounting issues related to
purchase commitments.

9-24


Valuation Bases
Valuation Using Relative Sales Value
Used when buying varying units in a single lump-sum purchase.
Illustration: Woodland Developers purchases land for $1 million
that it will subdivide into 400 lots. These lots are of different sizes
and shapes but can be roughly sorted into three groups graded A,
B, and C. As Woodland sells the lots, it apportions the purchase

cost of $1 million among the lots sold and the lots remaining on
hand. Calculate the cost of lots sold and gross profit.

9-25

LO 3 Explain when companies use the relative
sales value method to value inventories.